Another Financial Double-Whammy for the Marijuana Industry

The marijuana industry has been fighting an uphill battle for decades, but in recent years you could argue that it's been winning.

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The marijuana movement pushes forward Following decades of little to no support for a sweeping nationwide legalization of the currently illegal drug, nearly two-dozen states (and Washington D.C.) have passed legislation for medical marijuana since 1996. Taking it one step further, four states (and Washington D.C.) also allow consumers to purchase marijuana from licensed shops for recreational use.

Why the sudden change of heart on the part of consumers and states?

For consumers, I'd guess it's one of three main drivers. First, legalization could allow millions of chronically ill and terminal patients access to medical marijuana, which has been shown in certain studies to alleviate the symptoms associated with certain diseases and disorders. Secondly, as a survey from Gallup recently pointed out, more than 40% of those surveyed have tried marijuana previously, meaning people are more directly affected and opinionated about the legalization effort. Lastly, it could just represent freedom from federal laws superseding state laws.

For states, the marijuana movement means dollar signs. Excise, state, and local taxes collected from the sale of marijuana can help bridge budget deficits, fund education, and could even result in more jobs. To be clear, NerdWallet anticipated a nationwide legalization would result in only $3.1 billion in annual tax revenue, so it isn't going to singlehandedly close large budget shortfalls. However, it's a step in the right direction to creating more revenue for states.

But one substantial hurdle stands in the way of the marijuana industry, which has the potential to stop it in its tracks.

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Source: Pictures of Money via Flickr.

The financial hurdle that could stop the marijuana industry in its tracks Last month, Fourth Corner Credit Union, a credit union set up in Colorado (one of the four states to legalize marijuana across the board), faced a double-whammy: rejections from the Federal Reserve and the National Credit Union Administration, or NCUA, when it attempted to satisfy all of the requirements necessary to begin acting as a financial service institution for the marijuana industry. Fourth Corner wanted to bring basic checking services, lines of credit, and other financial instruments to an industry that's currently very underbanked, and which in many cases deals strictly in cash and money orders.

In 2014 the U.S. Treasury Department issued guidelines on how larger financial institutions could accept money from legal marijuana shops, but most banks declined to extend their hands to the marijuana industry considering the federal view that the plant is still illegal, and due to the complications of the banking workarounds. It's left the industry with few sources of credit other than speculative investors willing to lend cash upfront at high interest rates.

In early July, the NCAU sent Fourth Corner a letter declining their request for deposit insurance. Instead of citing solely marijuana's status as an illegal substance, the NCAU also referenced the fact that the marijuana industry "does not have an established track record of success and remains illegal at the federal level." In mid-July, the Federal Reserve rejected Fourth Corner's application for a master account, which would have allowed the credit union to interact with other financial institutions.

Source: Brett Levin Photography via Flickr.

Long story short, after big banks in Colorado failed to step up to the plate and Fourth Corner Credit Union was formed in order to fill the financial needs of the marijuana industry, insurers and regulators have prevented the Credit Union from getting its feet off the ground. In response, Fourth Corner filed lawsuits in the hope that federal regulators would overturn the decisions of the NCAU and Federal Reserve.

However, the damage has been done, and once again a precedent has been set that banks should not begin providing banking services to the marijuana industry. Without access to basic banking services it could be very difficult for shops and growers to expand their operations.

This is just one of many problemsOn top of a lack of basic financial service access, the marijuana industry continues to be plagued by the U.S. tax code, specifically section 280E, which doesn't allow for any sort of deductions for the primary business when it pertains to the sale of federally illegal substances, such as marijuana. For marijuana shops, this means paying taxes on gross profits before excise taxes and deductions, rather than on their net income, and it's leaving them with minimal profits (if any). Without tax code reform it may be incredibly difficult for marijuana businesses to make significant financial headway.

Source: GW Pharmaceuticals.

Marijuana businesses are also dealing with a generally apathetic group of politicians in Washington. President Obama has effectively labelled marijuana an issue of low priority, while a vast majority of the presidential candidates in 2016 have taken a negative or wait-and-see approach to the drug. In sum, those proponents hoping for rapid change probably aren't going to get it.

And finally, we have a lack of substantive mature marijuana data from clinical studies. This isn't to pass judgment on medical marijuana one way or another, so much as it's a reflection of decades of data focused on the drug's negatives rather than its possible benefits. Government and university researchers, as well as pharmaceutical companies such as GW Pharmaceuticals, which is examining the role of cannabinoid-based compounds in treating certain types of diseases ranging from cancer to type 2 diabetes, are hard at work examining the possible benefits of marijuana. Unfortunately, their data will take some time to mature.

This week's takeaway is that investing in this industry and hoping for rapid change is probably not a wise move. Without material changes at the federal level (e.g., scheduling of the drug, tax code, and access to financial institutions), the viability of the marijuana industry remains in question, which makes marijuana stocks an incredibly risky proposition.